Profits Decline For Firms Building New Subs

NEWPORT NEWS — Escalating costs in the Navy's Virginia-class submarine program are eroding the profit margins once expected by the two companies building the boats.

Northrop Grumman Newport News and General Dynamics' Electric Boat division in Groton, Conn. -- the defense giants jointly building the boats in an unusual teaming arrangement -- stand to see their profits from the first four vessels fall by about 25 percent because of the rising costs, according to recent figures the Navy provided to the Daily Press.

The Navy said the companies now stand to earn $411.7 million for the work, down from the $547.2 million they were projected to make when the initial contract was signed just over five years ago. That's a decrease of $135.5 million, or 24.8 percent, which amounts to a fee reduction of $67.8 million at each yard, assuming they split their profits evenly.

Both companies disputed those figures, but would not provide any further details about why they're wrong. "We believe those numbers to be incorrect," said Northrop Grumman Newport News spokeswoman Jerri Fuller Dickseski.

Financial analysts said the declining margins on the subs are large enough to be noticed at the upper echelons of Los Angeles-based Northrop Grumman and Falls Church-based General Dynamics.

But the analysts added the reductions are not big enough to dent the stock prices of either company significantly, or otherwise hurt them. Both companies are large, with programs in an array of areas. And the reductions are spread out over a construction job lasting about nine years.

"I'm sure the companies would not say it's insignificant, because they watch their dollars very closely," said Paul H. Nisbet, an analyst with JSA Research Inc. "But for companies the size of Northrop Grumman and General Dynamics, that's really not an awful lot of money."

The Virginia-class program, which is scheduled to include 30 boats eventually, is intended to serve as the Navy's replacement for some of its aging Los Angeles-class attack submarines. Of 51 remaining vessels in that group, 20 will hit retirement age by 2020.

The nuclear-powered attack subs are designed to carry Tomahawk cruise missiles, have the ability to drop off Special Forces troops near the shoreline and provide improved surveillance. The first vessel in the class, the Virginia, is slated to enter the fleet in August in a commissioning ceremony at the Norfolk Naval Station. The second ship, the Texas, is set to be christened at the Newport News yard this summer.

Building the first four subs -- the Virginia, Texas, Hawaii and North Carolina -- employs more than 6,000 people in Newport News and New England. At Northrop Grumman Newport News, the program provides more than 90 percent of the yard's submarine revenues. And the two companies recently were awarded a $8.45 billion contract to build another six boats beyond the initial four.

But the program's rising costs have recently led to criticisms in Congress. Because of the concerns, lawmakers rejected in the last term the Navy's requests for advance money for two subs a year in 2007 and 2008, rather than the current one a year.

When construction was getting started in 1998, the Navy told Congress the price of the first four subs would be $9.4 billion. Now, the current projected cost is $10.61 billion. That's an increase of $1.21 billion, or 13 percent, with at least three years left to go before the subs are done. So far, Congress has had to dole out another $854 million to cover the overruns, and the Navy has shuffled additional money into the program from elsewhere in its budget.

The main source of the increase: shipyard construction, which is up 19.6 percent from initial projections. Other costs, like the design and government-furnished parts such as electronics and the nuclear reactor, are up about 8 percent.

When the Navy and the two companies negotiated the contracts on the first four subs in 1998, they estimated the shipyard portion of the work at $4.24 billion. That included a construction price tag -- the cost of labor, materials, overhead and other direct costs -- of $3.69 billion, the Navy said. It also included a profit margin of $547.2 million.

Now, the contract with the two yards is projected to cost $5.07 billion, the Navy said. The estimated construction cost has grown by 26.2 percent, to $4.66 billion. That's partially offset by a reduction in the profit to $411.7 million, since under the terms of the contract each yard has to cover part of the overruns.

Navy Capt. John Heffron, the program manager for the Virginia-class subs at the Naval Sea Systems Command, cited bad inflation estimates as a primary reason for the increases.